How A Community Bank Tripped On Footnote 1,861 Of The Volcker Rule

When people talk about the Volcker Rule, they often mention JPMorgan Chase, the giant bank where a trader recently made a bad bet that lost $6 billion. The Volcker Rule is supposed to put an end to that sort of thing, by prohibiting banks from trading with their own money.

But some banks that are very, very different from JPMorgan Chase are struggling with an obscure provision in the rule. Specifically, footnote 1,861, which bars banks from investing in something called trust-preferred securities — a rather obscure investment favored by lots of small, community banks invest

Tioga State Bank is headquartered in Spencer, a village in upstate New York with a population of about 800 people. The bank mostly makes loans to local people and businesses. But Robert Fisher, bank's president, says trust-preferred securities make up a large chunk of his bank's annual income. "It's a big deal," he told me.

Nathan Stovall, who covers the banking industry for SNL Financial, says the regulators just don't want banks investing in anything that could even smell risky.

"What they're trying to do is say, 'We want you to be a lender, period. And since you're investing some of those deposits in bonds, we want it to be in really vanilla stuff,' " Stovall said.

The American Bankers Association does not consider these particular investments risky, and is challenging the rule, saying some community banks could have to close their doors over this footnote in the rules. And the regulators and Congress are reconsidering.

It turns out, it's hard to figure out which risks banks should be allowed to take, and which they shouldn't.

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Transcript

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This is ALL THINGS CONSIDERED from NPR News. I'm Audie Cornish.

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And I'm Robert Siegel. Have you ever gotten into trouble for something that your big brother did? Well, that's what some bankers are saying is happening with a new rule designed to regulate the banking system. NPR's Zoe Chace reports for our Planet Money team.

ZOE CHACE, BYLINE: Lots of big banks have been getting into trouble lately as lawsuits multiply over stuff that went on at the too-big-to-fail banks, during the financial crisis. According to analysis from SNL Financial, JPMorgan has paid out more than $26 billion, Bank of America $44 billion. And now there's Tioga State Bank.

RICHARD FISCHER: Tioga State Bank, we're a community bank in upstate New York. Our headquarters is in the village of Spencer, New York, which is - has about 800 people in the village of Spencer.

CHACE: Are you one of those banks that's like too big to fail, would you say? Are you a systemic risk to the economy?

FISCHER: People might say I'm systemic in the village of Spencer, but no, for the economy, no.

CHACE: Richard Fischer is the bank president. He got caught up in Footnote 1,861 of this thing called the Volcker Rule. The Volcker Rule is supposed to limit a potentially risky behavior the banks engage in called proprietary trading. Big banks have entire floors of traders using the bank's own money to speculate in the markets.

Maybe you've heard of the London whale trader who cost JPMorgan over $6 billion. He worked in the European headquarters of the investment bank, a 30-odd-flor skyscraper in London's financial district, makes Tioga State Bank look kind of shrimpy.

FISCHER: It's kind of a single-story building.

CHACE: So where's your - where's your big proprietary trading floor?

FISCHER: We don't have a proprietary trading floor. We take deposits. We make loans.

CHACE: So what is Fischer's bank doing wrong, according to Footnote 1,861? Well, it turns out banks like Fischer's have money leftover that they haven't lent out to the area for businesses or for new homes or whatever, and they use some of that money to buy a popular investment. It's called a trust-preferred securities. You don't need to remember the name. The point is the footnote makes this investment against the rules.

So Fischer's possibly going to have to sell these off and take a hit.

FISCHER: It's 25 percent of my annual income. So it's a big deal.

CHACE: It's a big deal and ridiculous, according to Fischer, that a bank like his that had nothing to do with the financial crisis shouldn't be allowed to hold on to an investment that had nothing to do with the financial crisis. Nathan Stovall, who covers the banking industry for SNL Financial, says the regulators just don't want banks investing in anything that could even smell risky.

NATHAN STOVALL: What it's trying to do is say we want you to be a lender, period. And since you're investing some of those deposits and bonds, we want it to be in very vanilla stuff.

CHACE: The American Bankers Association does not consider these particular investments risky and is challenging the rule, saying some community banks could have to close their doors over this footnote in the rules. So the regulators are reconsidering. It turns out, it's hard to write the rules over what could pose a risk to the taxpayers and what won't. The new rules that govern the banks, they are currently 6,810 pages long and counting. Zoe Chace, NPR News. Transcript provided by NPR, Copyright NPR.